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15. Fair Value Measurements and Financial Instruments
Accounting standards establish a three tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
· Level 1 — observable inputs such as quoted prices for identical assets in active markets;
· Level 2 — inputs other than quoted prices for identical assets in active markets, that are observable either directly or indirectly; and
· Level 3 — unobservable inputs in which there is little or no market data which requires the use of valuation techniques and the development of assumptions.
The following methods and assumptions are used to estimate the fair values of the Company’s financial instruments:
Money market funds and highly liquid debt securities are carried at cost and amortized cost, respectively, as an approximation of fair value. Based on market convention, the Company considers cost a practical and expedient measure of fair value.
Fixed maturity investments are carried at fair value, which is based on quoted market prices or on estimated values if they are not actively traded. In some cases where a market price is not available, the Company will make use of acceptable expedients (such as matrix pricing) to estimate fair value.
Derivatives are carried at fair value, based upon industry standard valuation techniques that use, where possible, current market-based or independently sourced pricing inputs, such as interest rates, currency exchange rates, or implied volatilities.
Debt is carried at outstanding principal balance, less any unamortized discount or premium. Fair value is based on quoted market prices or estimates using discounted cash flow analyses based on current borrowing rates for similar types of borrowing arrangements.
The following tables present the categorization of the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2011 and December 31, 2010 (in millions):
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Fair Value Measurements Using |
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Quoted Prices in |
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Significant |
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Significant |
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Active Markets |
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Other |
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Unobservable |
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Balance at |
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for Identical |
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Observable |
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Inputs |
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September 30, 2011 |
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Assets (Level 1) |
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Inputs (Level 2) |
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(Level 3) |
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Assets: |
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Money market funds and highly liquid debt securities (1) |
|
$ |
2,500 |
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$ |
2,450 |
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$ |
50 |
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$ |
— |
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Other investments |
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|
|
|
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Fixed maturity securities |
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|
|
|
|
|
|
|
|
|
Corporate bonds |
|
12 |
|
— |
|
— |
|
12 |
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|
Government bonds |
|
3 |
|
— |
|
3 |
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— |
|
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Derivatives |
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|
|
|
|
|
|
|
|
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Interest rate contracts |
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15 |
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— |
|
15 |
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— |
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Foreign exchange contracts |
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137 |
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— |
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137 |
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— |
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|
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|
|
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Liabilities: |
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|
|
|
|
|
|
|
|
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Derivatives |
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|
|
|
|
|
|
|
|
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Foreign exchange contracts |
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180 |
|
— |
|
180 |
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— |
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(1) Includes $2,450 million of money market funds and $50 million of highly liquid debt securities that are classified as fiduciary assets, short-term investments or cash equivalents in the condensed consolidated statements of financial position, depending on their nature and initial maturity. See Note 8 “Investments” for additional information regarding the Company’s investments.
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Fair Value Measurements Using |
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Quoted Prices in |
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Significant |
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Significant |
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Active Markets |
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Other |
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Unobservable |
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Balance at |
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for Identical |
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Observable |
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Inputs |
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|
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December 31, 2010 |
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Assets (Level 1) |
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Inputs (Level 2) |
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(Level 3) |
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Assets: |
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|
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Money market funds and highly liquid debt securities (1) |
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$ |
2,618 |
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$ |
2,591 |
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$ |
27 |
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$ |
— |
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Other investments |
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|
|
|
|
|
|
|
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Fixed maturity securities |
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|
|
|
|
|
|
|
|
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Corporate bonds |
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12 |
|
— |
|
— |
|
12 |
|
|
Government bonds |
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3 |
|
— |
|
3 |
|
— |
|
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Derivatives |
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|
|
|
|
|
|
|
|
|
Interest rate contracts |
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15 |
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— |
|
15 |
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— |
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Foreign exchange contracts |
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159 |
|
— |
|
159 |
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— |
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|
|
|
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|
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|
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|
|
|
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Liabilities: |
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|
|
|
|
|
|
|
|
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Derivatives |
|
|
|
|
|
|
|
|
|
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Foreign exchange contracts |
|
158 |
|
— |
|
158 |
|
— |
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|
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|
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(1) Includes $2,591 million of money market funds and $27 million of highly liquid debt securities that are classified as fiduciary assets, short-term investments or cash equivalents in the condensed consolidated statements of financial position, depending on their nature and initial maturity. See Note 8 “Investments” for additional information regarding the Company’s investments.
The following table presents the changes in the Level 3 fair-value category (in millions):
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Three months ended September 30, |
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Nine months ended September 30, |
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|
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2011 |
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2010 |
|
2011 |
|
2010 |
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|
|
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Other Investments |
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Other Investments |
|
Other Investments |
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Other Investments |
|
|
Balance at beginning of period |
|
$ |
12 |
|
$ |
21 |
|
$ |
12 |
|
$ |
100 |
|
|
Total gains (losses): |
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|
|
|
|
|
|
|
|
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Included in earnings |
|
— |
|
— |
|
— |
|
— |
|
|
Included in other comprehensive income |
|
— |
|
1 |
|
— |
|
— |
|
|
Purchases |
|
— |
|
— |
|
— |
|
— |
|
|
Sales |
|
— |
|
(10 |
) |
— |
|
(1 |
) |
|
Transfers (1) |
|
— |
|
— |
|
— |
|
(87 |
) |
|
Balance at end of period |
|
$ |
12 |
|
$ |
12 |
|
$ |
12 |
|
$ |
12 |
|
(1) Transfers represent the removal of the investment in PEPS I preferred stock as a result of consolidating PEPS I on January 1, 2010.
There are no realized or unrealized gains or losses related to assets and liabilities measured at fair value using level three inputs included in income for either the three or six months ended September 30, 2011.
The following table discloses the Company’s financial instruments where the carrying amounts and fair values differ (in millions):
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September 30, 2011 |
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December 31, 2010 |
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Carrying |
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Fair |
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Carrying |
|
Fair |
|
|
|
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Value |
|
Value |
|
Value |
|
Value |
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Long-term debt |
|
$ |
4,415 |
|
$ |
4,685 |
|
$ |
4,014 |
|
$ |
4,172 |
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